Tuesday, 4 June 2013

All bets are ON

Both the
government in Japan and many investors are betting on the power of monetary
policy but it is not much more than a roll of the dice.

Japan has long suffered at the hands of the same problems
that have hit Europe, and as a result, the central bank in Japan has also been
a pioneer of the loose monetary policy which has since become the mainstream
response to such problems. The
recently-elected Japanese government has upped the stakes with a further round of monetary policy which goes far beyond anything
previously proposed. Investors too have
been putting their money on the line in the hope that the new measures will bring about a long
awaited revival in the Japanese economy.
However, the limited effect of monetary policy so far in the aftermath
of the global financial crisis suggests that this is nothing more than a gamble
in order to avoid some tougher choices.

A massive financial bubble in Japan in the late 1980s has
resulted in two decades of economic stagnation due to the now common culprits
of the overpriced real estate market,
overwhelming government debt, and a lack of sources of growth. The interest rates have been set close to
zero for more than a decade while the Bank of Japan has also pumped money into
the economy. Successive Japanese
governments have held back from making the necessary reforms to help the
economy unwind the imbalances built up during the boom years and instead
amassed debt equal to 230% of GDP, rather than
deal with the problems that the country is facing.

The new wager on monetary policy involves a doubling of the
money supply as part of measures to achieve inflation of around 2% in two
years. However, the new monetary
measures will just be another stalling tactic if not combined with other
policies which help to kick start business activities. The immediate effect of printing more money
is that the value of the yen has dropped from below Y80 to over Y100 against
the US$. A weaker yen is a boon for many
of Japan’s manufacturing giants who have large exporting operations. The boost to their profits along with hopes
for a new beginning for the Japanese economy has prompted many investors to
throw in their lot with the Japanese government and the stock market surging by
almost 70% in 6 months until a
recent setback.

Yet this is symptomatic of actions by governments and
investors across the globe. Booms and busts in any economy involve
considerable transformation as businesses adjust to new realities and
government can either try to facilitate this process of companies adapting, which helps the economy become more productive over the
long term, or stand up against forces of
inevitable change to ease the short term pain.
Prior faith in monetary policy has enabled governments to believe that
central banks have the power to restart economic growth with less
hardship. But new engines of growth are
not given the scope to expand and monetary policy is relied upon more and more
to prop up the economy. And using monetary policy to weaken a currency and
boost exports will only work as long as the country’s central bank is expanding
their money supply faster than anywhere else (for more on this, see Currency Wars).

This complicates the process of selecting investments with a
layer of politics being overlapped with normal considerations of business
profits and economic performance. And
with monetary policy taking a more dominant role in the strength of the
economy, investors find it necessary to track the actions of central banks
rather than just corporate activities and economic indicators. As such, investors are second guessing what
the central banks will do while the central banks take their best shot at what
they think will be good for the economy.

It is questionable whether the current set of policies that
are commonly employed by central banks have been of much use so it is a considerable punt by the
Japanese government to put all its money on more of the same despite any
consensus which suggests otherwise. But
it is a way of being seen to be proactive while actually avoiding backing more
difficult choices which are more likely to pay off in the long term. And with bets in the stock market following
the government line, this will multiply the losers and add to the woes of those
who actually try to sort out the mess in the future.